Financial sustainability multipliers – show the extent to which a company is credited and its ability to service its debts and solvency multipliers – show the ability of a company to pay its debts through both cash and asset sales.
The multipliers are financial derivatives by which investors assess the investment attractiveness of a business in isolation from its scale. They show the relative characteristics of the business without clouding the mind with billions.
Financial stability characterizes a firm’s dependence on borrowed capital and shows the level of its financial risk.
First of all, it is the leverage ratio debt to equity. This is the ratio of the company’s debt to equity. D/E = Debt(Liabilities) / Equity Borrowings include both long-term and short-term liabilities. The multiplier shows how many rubles of borrowed capital accounts for 1 ruble of own funds.
At high values of the ratio, an organization loses its financial independence, and its financial position becomes extremely unstable. It is more difficult for such organizations to attract additional loans. The normative value in the domestic practice is the value of leverage ratio equal to 1, i.e. equal shares of both liabilities and equity. In developed countries, as a rule, the leverage ratio is 1.5, i.e. 60% of borrowed capital and 40% of equity.
Let’s calculate the leverage ratio for nvidia, for this purpose let’s look at the financial report. We divide the total debt of 3.743 billion into shareholders’ equity equal to 7.717 billion. We get the value equal to 0.48. That means the company took 48 cents for every dollar of its own capital.
There is also a property or financial dependency ratio Debt ratio – a ratio characterizing the ratio of the organization’s debt capital to all assets of the company. Debt Ratio = Total / Total Assets.
It shows to what extent an organization is dependent on external sources of financing, i.e. how much borrowed funds the organization has attracted for 1 rub. of its own assets. It also shows the measure of the ability of the organization, having liquidated its assets, to fully pay off accounts payable.
Normal is the value of the indicator not exceeding 0.6-0.7. The optimal value of the financial dependency ratio is 0.5. A low value characterizes low bankruptcy risk and good solvency.
Let us calculate the level of financial dependency for nvidia. We divide the total debt of 3.743 billion into 11.460 billion assets. As a result, we have the coefficient of 0.32.
Various coverage ratios are calculated among the solvency multipliers. The main one is Debt Service Coverage Ratio. It is used to assess the business’s ability to meet its debt obligations. Debt Coverage Ratio is calculated as net operating income divided by the amount of debt obligations. Debt service = Net operating income / Total debt service.
The calculation of this ratio is one way to determine whether a company can meet its debt obligations if all of its creditors immediately demand their funds. If the value of the debt coverage ratio is less than one, it may indicate a financial problem.
Nvidia has an operating flow of 3.210 billion dollars. We divide it by total debt, i.e. 3.743 billion. The result is 0.85.
We also calculate the Current Ratio (current ratio), which shows the ability to repay current (up to a year) liabilities of the organization. Creditors widely use this ratio in assessing the current financial situation of the organization and the danger of short-term loans issued to it. The current liquidity ratio is calculated as the ratio of current assets to short-term liabilities current ratio = Current Assets / Current Liabilities.
The higher the value of the current liquidity ratio, the higher is the liquidity of the company’s assets. Normal, and often optimal, is the value of the coefficient of 2 or more. However, in the world practice it is allowed to reduce this indicator for some industries to 1.5.
The current assets of nvidia are equal to 9.448 bln, and short-term liabilities are equal to 1.106 bln. By dividing these values we will get the coefficient of 8.54.
It is worth remembering that:
The multipliers reflect the ratio between the market capitalization of the company and the financial performance of the business. This helps to compare different companies on a single scale. Underappreciated companies are less exposed to risk. Companies should be analyzed on the basis of multipliers by a set of all indicators, not by one. The multipliers are best used to compare companies from the same industry, thus adding the best companies from each sector to your portfolio.